ROOT OF THE PROBLEM

4 February 2009Even government commitments to PPPs can't help if there simply isn't enough money in the bank's pot. Rebecca Omonira-Oyekanmi looks at what the liquidity crisis means for the market.

UK business minister Baroness Vadera has denied she is out of touch after claiming she could see "a few green shoots of economic recovery" but few industries have much to smile about. Even PPP projects, seen as one of the securer investments, have hit a brick wall called liquidity. Flagship projects are struggling to close and government spending plans are in danger of grinding to a halt.

Despite fighting talk from government officials the private sector has little confidence they will deliver. Senior executives from around the world say they are concerned about the state of infrastructure and fear governments are doing little to alleviate the funding gaps.

A recent report by KPMG and the Economist Intelligence Unit questioned senior bosses in companies operating in Asia-Pacific, Eastern Europe, Latin America, Middle East and Africa, North America and Western Europe on the infrastructure gap.

‘Bridging the Global Infrastructure Gap: Views From the Executive Suite’ found that few respondents were confident about the long-term availability of funds for infrastructure investment. It notes: "Even the economic optimists responding to our survey fear there won’t be enough money to invest in infrastructure." The researchers asked those who predicted economic conditions would worsen what factors would inhibit growth of the infrastructure industry. In total 95% said the economy, 77% government effectiveness and 73% said availability of skills.

Nick Chism, head of KPMG’s Global Infrastructure Practice, said: "These findings highlight widespread concern among global business leaders that governments need long-term strategies for infrastructure, adequately funded and backed by political will." In the UK, projects with prior banking commitments have limped through to financial close, but others haven’t been so lucky.

Large-scale deals, including the £3bn Greater Manchester waste PFI and the £5bn M25 project, have been delayed as they struggle to co-ordinate the banking clubs that have become the mainstay of PPP funding.

Other projects have faired better, such as the M80 PFI in Scotland, only after the EIB stepped in with extra funding. It has also agreed to support the government’s sizeable BSF programme. The financing issues knocking PFIs are well known in the industry, but have only recently made the national papers. According the reports in the Sunday Times a leaked email revealed that a health minister Alan Johnson feared for the long-term future of the NHS capital building programme. Johnson told NHS bosses that, "2010/11 and forward is going to get really tight" at a Whitehall meeting last month.

The email’s author, Graham Eccles, chairman of the South East Coast Strategic Health Authority, wrote: "PFIs have always been the NHS’s ‘Plan A’ for building new hospitals, especially as they used to be off balance sheet.

"There was never a ‘Plan B’. Now none of the banks have any money or are likely to have any for a few years, the absence of a ‘Plan B’ is going to cause a real problem in taking new hospitals to conclusion."

Shadow health minister Andrew Lansley blamed prime minister Gordon Brown’s "economic mismanagement", saying the consequences for hospital PFIs would be disastrous. A spokesman for Lansley added that the government has been too reliant on PFI and according to parliamentary reports is locked in contracts worth £60bn over the next 30 years. He added that the NHS’s capital budget for traditionally procured projects was not being spent with millions shored up each year.

However, the Department of Health hit back saying, "It would be difficult of course to raise funding in the current market and more expensive. But the plain fact is that there is currently only one NHS scheme in the market at the moment, and this won’t sign contracts until later this year. There are a number of major NHS schemes currently working up business cases with PFI proposals, but these won’t have to raise finance for at least another 18 months."

Wilson admits that, "Sectors of the economy relying on private finance are currently facing significant challenges, while local authorities are experiencing wide variations with project delivery." But he insists that there is still a place for PFI in the delivery of public services. He said: "Despite delays to the financial close of some projects, we believe the benefits PFI procurement techniques have brought to the public sector will be maintained."

With a PFI pipeline of £8bn for 2009 Wilson says that the government will do whatever it takes to ensure delayed projects reach financial close. A UK banker recently told the PPP Bulletin, "Loan tenors will shorten and more deals will be done on a seven-year basis in line with a number of precedents in continental Europe. Refinancing risks and benefits will need to be agreed between sponsors and the public sector. Other loan terms will tighten and there will be greater focus on the strength and support packages for construction and operating subcontractors."

But none of this is new. At the end of last year Andy Rose, executive director at Partnerships UK said: "The monoline wrapped bond market, which has been the financial structure of choice for large PFI projects over the past 10 years, is now effectively closed to new transactions. This has increased reliance on the banking market. The combination of capital adequacy requirements, reduced liquidity and higher funding costs has increased the strain on the project finance banking model. While the banks’ views of the PFI risk profile have not changed materially, funding availability is limited and credit margins have moved up."

But what has changed is that margins on PPP debt are now being quoted in the 200 to 250 plus range. Some commentators say it is debatable whether margins will ever go down to those seen immediately before the credit crunch.

Cash in the attic

The UK is not alone. Although it initially seemed that Canada could escape the worst of the downturn, several high profile projects are struggling to raise funding include the $800m Golden Ears Bridge P3. The project is being funded by Depfa Bank, part of Hypo Real Estate who has had to take up a €50bn bailout package from the German government.

Another flagship highway project, the $1.6bn Port Mann P3, has been thrown into doubt after lead sponsor Macquarie had difficulties raising funding.

Financial close for the DBFO project could be delayed until March according to Partnerships BC chief executive, Larry Blain. He said: "We gave one extension to Macquarie because the markets are difficult, banks are doing more due diligence, they are more picky about projects."

Transport minister Kevin Falcon issued a statement saying that the province had agreed to give Macquarie more time to complete its loan for the P3 "in response to the current challenges facing the capital markets."

He added: "Macquarie advised government that they remain confident that they will be successful in completing lending syndication. The province of BC will wait and see the results of the proponents’ effort, but regardless remain committed to the Port Mann project utilising alternative means of financing should that be necessary."

But despite funding issues James Bennett, investment director at John Laing, is confident that the Canadian P3 market will pick up towards the end of the year. However Bennett does admit that "there just may not be enough banking capacity in the market" to cover the cost of finance. The message from Canada seems to be that touting projects of more than $500m to banks – for the next six months at least – might not be a good strategy.

Over in the US, there was some disappointment about the relatively small amount Barack Obama devoted to long-lasting infrastructure investments in favour of spending on a long list of government programmes. The American Society of Civil Engineers estimated that the president’s stimulus package contained some $90bn in infrastructure spending, however an industry source said that, "Unofficially the numbers for infrastructure in Obama’s package are coming out lower than most people expect. Shockingly low to the point of 10% stimulus and 90% about PPPs. The alternative to no cash is clearly PPPs."

And unlike the mature markets in Canada and the US, these projects should be reaching financial close once the banking markets have stabilised. It seems that the US P3 market may have escaped the worst.

Changing tack

The shortfall in private finance has driven governments to look outside the banks to fund their programmes.

In a bid to prevent the programme from grinding to a halt due to uncertainty in the credit markets, the UK’s schools delivery agency has announced it would stagger financial close for projects. This enables the design and build aspects of the PPP to close leaving the remaining stages subject to funding decisions.

The first staggered BSF PPP reached part financial close last month in Newham where the council signed off the design & build aspects of its £200m PPP with a consortium comprising Laing O’Rourke and IT firm RM. The PFI component of the project is expected to close over the next few months.

Other countries are using a similar approach. In Poland the government has awarded the A1 motorway PPP to a Cintra-led consortium and has arranged for the design and construction to start on the same day as contract award but allowing 12 months to reach financial close. A release by Cintra says that, "The concession’s economic parameters will be assessed and adjustments will be proposed due to the impact of the current economic and financial crisis on funding conditions and costs, on capital costs and on traffic projections as compared with those that obtained when the bid was presented.

If the terms are not agreed, the contract may be cancelled by either Cintra or the Polish government in which case the concession company will recover the costs incurred in design and construction.

With the need for investing in infrastructure undiminished but with the current climate making financing increasingly challenging, we could expect to see more of the same over the coming year.